Insolvency proceedings are complex and offer no guarantee that secured creditors will recoup their funds. Harry Upcott investigates the insolvency regimes in key jurisdictions and asks whether restructuring is a more attractive option

Since the last quarter of 2008, it has become increasingly clear that financial institutions are not the only casualties of the economic crisis. As corporate defaults increase, secured creditors, borrowers and subsidiary security providers are focusing on two things: the security packages that have been granted in connection with outstanding borrowings and debt issues, and the implications of security provider insolvency.

Insolvency is a complex area of the law and it should be remembered that the rights of creditors and security providers are usually determined by the jurisdiction in which the secured asset – the collateral – is located. In today’s globalized economy, many corporates have subsidiaries in different jurisdictions, each of which has its own rules and procedures governing the recognition of security, the right to enforce, the enforcement process, the impact of insolvency and the distribution of enforcement proceeds. Given this reality, the importance of obtaining local law advice cannot be stressed enough.

Insolvency is a state of affairs, not a formal procedure in itself. In the UK an entity can be either “balance sheet” insolvent (where liabilities exceed assets) or “going concern” insolvent (where it cannot pay its debts as they fall due). Other jurisdictions (including the US) use the term “bankrupt”, but in the UK this term is used only in relation to insolvent individuals.

Approaches to security

For convenience, lawyers often categorize jurisdictions as either pro-creditor or pro-debtor. In the context of security interests, the category in which a jurisdiction falls is determined by the following indicators: 1. the extent to which a company can grant security over all its present and future assets; 2. whether there are complex or expensive perfection requirements such as notarization, legalization, stamp duties, registration fees and the scope of filing requirements on public/asset registers; 3. whether trustees of security are recognized so that the collateral is not treated as part of the trustee’s estate on insolvency; 4. whether enforcement by private sale is allowed, or whether judicial order is required; 5. whether insolvency proceedings freeze enforcement rights; and 6. the circumstances in which security can be set aside as a voidable preference transaction at an undervalue or equivalent.

Generally, the common law group (which includes India as well as the UK, US, Canada, Pakistan, New Zealand, Australia and Hong Kong) are the most creditor-friendly jurisdictions. The Germanic-based jurisdictions (including Germany, Scandanavia, Russia, Indonesia and Turkey) fall somewhere in the middle (as does China, which has both common and civil law influences), while the French group (including France, Spain, Italy, South America and much of Africa) are firmly in the pro-debtor camp.

Security involves the right of a creditor to have a particular debt repaid from the proceeds of a sale or income generated by a specific asset. “True” security interests, created by an agreement between the creditor and the debtor, should be distinguished from what is often termed “quasi security”, which includes guarantee claims, set-off rights, retention of title, leasing and flawed asset arrangements. Moreover, the term “security” should not be confused with “securities”, which refers to investment instruments such as listed shares and bonds.

How secure is security?

The main objective of security is to protect the creditor in the event of insolvency by the debtor. This protection may include priority of payment before other creditors, often as a result of the creditor forcing a sale or other realization of the collateral; control over the security provider, including the ability to replace the management and influence the running of the business; and leverage against the borrower and other creditors.

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Harry Upcott is a UK-qualified consultant in the Singapore office of Allen & Overy. His practice covers a wide range of sectors including acquisition finance, asset finance (with specialist expertise in the aviation and shipping sectors), structured finance, syndicated lending and telecoms finance.